Since September of 2007, the Federal Reserve Chairman has slashed the federal funds target rate by a full 3 percentage points. But prospective buyers are still scratching their heads because the Interest Rates are not moving down with these cuts. Interest rates have dropped only a 1/2 percent on a 30-year fixed loan since September. Why is this happening?

Here is a overview of the factors that influence today's mortgage rates and my opinion of what may be happening in the future.

DOES THE FED SET MORTGAGE RATES?

No. The Fed is only responsible for setting the federal funds target rate. What is the Federal Funds Target Rate? This is the interest rate that banks charge each other for overnight loans. Interest rates on short-term CD's and commercial paper are closely linked to the federal funds rate., but its influence on fixed-rate mortgages is less direct.

DOES THE FEDERAL FUNDS RATE AFFECT MORTGAGE RATES?

Only indirectly. The federal funds rate affects a lender's borrowing cost. When the federal funds rate is cut, lenders pay less for the funding they need to finance loans. Based on this, they can reduce the interest rates they charge on mortgages without hurting their profits.

SO WHAT ARE THE KEY FACTORS THAT DETERMINE MORTGAGE INTEREST RATES?

Fixed mortgage rates usually track the yield on the 10-year Treasury note. On average, people payoff (refinance) their loan every 7-10 years. The outlook for inflation plays a key role in determining the yield on the 10-year Treasury.

In order to compensate lenders and investors for the risk that they take on home loans that may not be repaid, mortgage interest rates are set higher than the 10-year Treasuries, which are basically risk free. In the past, the difference between mortgage rates and the 10-year treasury yield has been approximately 1 1/2 percentage points. This is referred to, in the mortgage industry, as risk premium.

HOW HAVE THESE FACTORS INFLUENCED MORTGAGE RATES LATELY?

Recently we have seen the treasury yields decline in the past few months but the risk premiums have widened dramatically. The spread between the average 30-year fixed mortgage rate and the 10-year Treasury yield has ballooned nearly 60 percent year over year to approximately 2 1/2 percentage points.

WHAT IS DRIVING UP THOSE RISK PREMIUMS?

Mortgages were considered to be safe investments before the housing crisis. This kept risk premiums low. During the housing boom, large amounts of home loans were pooled together and sold to investors in the form of mortgage-backed securities. But as we have all seen in the news, rising delinquencies and foreclosures on subprime home loans led to large-scale losses for investors holding those loans.

With the demand for mortgage-backed securities slim to none, higher returns were required to attract new buyers, who were moving to safer or low-risk investments such as treasuries securities. Based on these factors, the banks tightened up all of their underwriting standards and guidelines and required a wider spread on new mortgages.

As a result, the recent declines in the yield of the 10-year Treasury have been more than offset by the escalating risk premiums. This has prevented mortgage rates from falling as mush as they normally would have.

WILL THESE RISK PREMIUMS DECREASE ANYTIME SOON?

As investor portfolios begin to heal from the housing market's demise, risk premiums should begin to decrease. At this time , the risk premiums have started to decrease, but they are still well above the historical norm. This is partially because of the recent changes allowing Fannie Mae and Freddie Mac to increase their holdings of mortgage backed securities.

WHAT IS THE OUTLOOK FOR THE 10-YEAR TREASURY?

Even though risk premiums are expected or may decline, the 10-year treasury yield is expected to increase.

SO WHERE WILL MORTGAGE RATES BE AT THE END OF THE YEAR?

No one can really say what will happen, but it is my opinion that interest rates will increase and or fluctuate between 5.875 and 6.25% between now and the end of the year. Rates could move lower if the the economy slips into a recession.

HOW ATTRACTIVE ARE CURRENT MORTGAGE RATES?

The lowest average 30-year fixed rate ever recorded by Freddie Mac's weekly mortgage survey was recorded at 5.21 percent in June of 2003. In August of 2007, the average rate was recorded at 6.625 percent. So I would say that interest rates are very attractive. Some borrowers can reflect and will remember that in the 90's we were seeing average interest rates in 10-12 percent range.

Based on all of the information that I see on a daily basis, I believe that nationally home owners and new home buyers are in the best position to take advantage of these low rates, lowering their monthly outgoing expenses and decreasing their financial risks.